ch11 - Chapter 11 Monopoly and Monopsony Solutions to...

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Chapter 11 Monopoly and Monopsony Solutions to Review Questions 1. A monopoly market consists of a single seller facing many buyers. Because the firm is by definition supplying the entire market, it faces the entire set of buyers making up the market demand curve. 2. Marginal revenue is less than price for a monopolist. This is because as it lowers its price two things happen. First, the firm’s revenue increases from the additional units it sells (these are the marginal units). Second, the firm’s revenue decreases because it loses revenue from selling units at a lower price than it could have had it chosen a lower quantity of output (these are the inframarginal units). The change in revenue is the sum of the increase from the marginal units and the decrease from the inframarginal units. This change can be summarized as TR P MR P Q Q Q = = + Since demand is downward sloping, the second term will be negative implying marginal revenue will be less than price. 3. The firm’s marginal revenue could be negative if the increase in revenue the firm gets from selling additional (marginal) units at a lower price is more than offset by the decrease in revenue from selling (inframarginal) units at a lower price than if it had chosen a lower quantity of output. Page 11 - 1
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If demand is price inelastic then % 1 % 1 1 0 Q P Q Q P P Q P P Q P P Q Q P P Q Q - - - < - + < But, P MR P Q Q = + Thus, when demand is price inelastic, marginal revenue is negative. 4. a) True. Because the firm is operating on the inelastic region of the demand curve marginal revenue is negative. Thus, decreasing output will increase total revenue. And, since output is lower, total cost will be lower. Thus, by decreasing output and increasing price the firm can increase profits. b) False. When the firm operates on the elastic portion of the market demand curve, increasing output will increase total revenue. In addition, increasing output will increase total costs. Thus, the effect on profit will depend on how costs increase in relation to revenue. 5. The firm will not be maximizing total revenue at the point where the firm maximizes total profit. The firm maximizes revenue at the point where 0 MR = and the firm maximizes profit at the point where MR MC = . Thus, unless 0 MC = , the firm will not maximize both revenue and profit at the same point. 6. IEPR is the Inverse Elasticity Pricing Rule. This rule states that a profit- maximizing firm that sets MR MC = will satisfy the condition that * * * , 1 Q P P MC P ε - = - Page 11 - 2
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where the asterisks indicate the price and marginal cost at the profit-maximizing level of output. 7.
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This note was uploaded on 09/24/2008 for the course PAM 2000 taught by Professor Evans,t. during the Fall '07 term at Cornell University (Engineering School).

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ch11 - Chapter 11 Monopoly and Monopsony Solutions to...

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